Rasgon, who has an Underperform rating on Intel shares, and an $18 price target, writes that the current versions of Intel’s chips, led by “Bay Trail,” are really aimed at high-end tablet computers, and that Intel is unlikely to get much traction in that part of the market, which is dominated by Apple (AAPL) and by Samsung Electronics (005930KS).

Intel is not likely to ever win a socket in Apple’s iPad, he thinks, and while Samsung has been willing to “throw the company a bone” now and then, “it is probable that Intel will not see an enormous volume opportunity from Sammy either.”

That’s okay, writes Rasgon, because the trend in the tablet market is one of new competitors eating away at Apple and Samsung’s lead, opening up lots of new opportunities for Intel. He cites a report last week by research firm IDC showing that sales were stronger in Q4 for tablet challengers such as Asustek (2357TW) and Lenovo (0992HK).

Those tablets are increasingly cheap models, mostly sub-$199, observes Rasgon. To compete, Intel is subsidizing its relatively high-priced “Atom” chips, such as Bay Trail, with rebates, which Intel refers to as “contra revenue.”

The problem, as Rasgon sees it, is that Intel’s projection for gross margin decline this year of 1.5 percentage points, on presumed sales of 40 million tablet chips sold, means that Intel’s actual cost on the chips is more than the $20 subsidy it has implicitly told the Street, more like $51 in embedded cost:

Intel’s guidance for 2014 incorporates the financial consequences of scaling the tablets strategy. The company has guided to flattish revenues, and gross margins of ~60%, which include a ~150 bps hit from the tablet subsidies, with a goal to move 40M tablets (up from ~10M in 2013). Now much of the math we have seen along these lines has been somewhat simplistic (e.g. “150 bps of GM on $53B in revenue is ~$800M/year in subsidies). In actuality, the math doesn’t work that way (indeed, this simplistic math understates the true magnitude of the costs as we will illustrate in a moment). Rather, “contra-revenues” take away from the top line – in other words, without the contrarevenues, Intel’s own revenues would be higher (under the assumption that they would still be able to sell their tablet chips), and gross margins would be consequently higher as a result of the higher revenues. However, working through the math properly yields a somewhat strange result. In fact, accounting for a 150bps hit to gross margins, strictly due to “contra-revenues,” would imply over $2B in rebates taken off the 2014 financials (e.g. Intel’s revenues would need to be $2B higher, on the same COGS base, to drive gross margins 150 bps higher than guidance). This would imply an average subsidy of over $51 per tablet, MUCH higher than Intel’s stated $20 or so, and which on the surface seems absurd (see Chart of the Week #3).

Rasgon concludes that with subsidies, Intel’s financial forecast implies it is going to sell tablet chips at cost. Without assuming subsidies, the forecast implies Intel will actually be selling the chips at a loss: “Our analysis suggests that Intel will likely not be selling tablet chips in 2014 for much above costs, with gross margins approaching zero, even before adding rebates into the mix.”

“And after rebates, the effective economics Intel is enjoying on tablets this year likely involves revenues close to zero, and profits that are negative (of course)…”

Rasgon offers the following table of his math (click for larger image):

Rasgon concludes that even with bad profitability, some progress in tablets won’t contribute much to revenue growth for Intel:

Even thought this market is likely to be in the hundreds of millions of units annually, how much revenue opportunity is Intel likely to enjoy? On those numbers, maybe a couple of billion dollars worth even if they get it all (which they likely wouldn’t). And even if they could somehow capture that much of the market, it wouldn’t go very far in moving the needle on a $50B+ company.

Inside Intel's (INTC) giant booth at the Las Vegas Convention Center at the Consumer Electronics Show today, I spent some time talking with the man leading the company's mobile computing charge, Hermann Eul.

Things will be a little different this year for Intel after some limited successes last year in smartphones and tablets. Last year, the company had what Eul referred to as “research projects” in phones, with a lot of its deals being private-label phones for carriers, such as France's Orange. “We're not going to do that anymore,” said Eul.

Intel's Atom finds its way into a new Asus smartphone, left, following a Lenovo model put out last summer.

Instead, the focus will be on actually selling the company's Atom chip to smartphone makers directly. There is already some progress there, with a unit last year made by Lenovo. “We have a very good relationship with Lenovo,” he notes. This week at the show Asus announced a forthcoming model with Atom in it. Other deals are in the pipeline, though Eul wouldn't name them.

As for tablets, last year saw an important win for Intel with Samsung Electronics (005930KS) in one of the Korean giant's 10-inch tablets running Google's (GOOG) Android software. Samsung's press conference on Monday was not as kind to Intel, as the newly announced Samsung tablets run Qualcomm's (QCOM) chips.

Eul calmly batted the matter away, observing “Samsung always has multiple sources for its chips,” including Samsung's own in-house chip effort. When I pressed him on whether that could mean Samsung tablets with Intel chips later on this year, he vaguely indicated his ascent to the matter without committing himself or Samsung to anything definite.

Eul was more interested in talking about a bright-orange tablet for kids called the “Nabi” that will be coming out later this year. It's big, it's rugged, it runs Google's Android, and it has little clips on the back of it that kids can use to attach plastic squares with letters for forming words and such. Pricing is not disclosed at this time, but Eul said it is meant to be a “premium” product, even though it is for children.

The Bay Trail-based Nabi tablet for kids.

Intel has two kinds of Atom chips for phones and tablets at the moment, both built in the company's 22-nanometer semiconductor process, “Bay Trail,” and “Merrifield,” with the former being targeted at tablets, the latter at smartphones.

Merrifield is especially important, as it will be the first time Atom offers its 64-bit support to mobile devices. Atom has had a 64-bit capability since its introduction in 2007, but 64-bit support was disabled in practice, in part because of power requirements of a mobile device. With the rising interest in 64-bit in smartphones and tablets, Intel is taking the gloves off. Google's Android doesn't currently support 64-bit memory addressing, but Intel is helping partners clear that hurdle: it has written its own 64-bit Android kernel. “We don't want partners to be held up” by Google's delay, said Eul. “And when Google does provide that, partners can just slot that code into place” on Merrifield systems, he says, in place of, or on top of, the Intel kernel.

Both Bay Trail and Merrifield have successors in the works, of course, as was described during Intel's analyst day back in late November. Bay Trail will transition to “Cherry Trail,” and Merrifield will transition to “Moorefield.” The former will use Intel's next-generation 14-nanometer technology, the latter will stay at 22-nanometer but move to four CPU cores from two.

While those chips are entering production this year and may sample to customers, Eul indicated they are somewhat more of a 2015 story as far as showing up in products. In 2015, Intel expects to unify tablet and smartphone lines with the so-called “Broxton” line, on 14 nanometer, again, disclosed at the analyst day. There is also a part with integrated baseband, “Sofia,” for less performance-intensive baseband.

We ended our conversation on the topic of semiconductor process technology and whether Intel has an edge. Intel had for awhile now been talking about the ways in which competitors will stumble when they run up against really hard semiconductor problems. The company has even warned of a “transistor cliff,” when the physics of circuitry make chips harder and harder at smaller sizes, perhaps too hard for anyone but Intel, something I wrote about during the show here last year.

Eul has a slightly different take on things. He points out that Qualcomm, and other competitors such as Nvidia (NVDA) and Broadcom (BRCM), all of whom are dependent on Taiwan Semiconductor Manufacturing to actually make the chips they design, will run into a problem as Taiwan Semi's technology stops scaling.

Intel had made the point at the analyst day presentation, and Eul repeated it: As TSM moves from 28 nanometer to 20 nanometer, it will run into a problem at the subsequent step, 16 nanometer, where TSM will not add any real reduction in transistor size. That, says Eul, means that 16-nanometer parts a few years from now will be stuck at a 20-nanometer feature size while intel presumably zooms ahead to 10 nanometer by that time.

Rear of the Nabi tablet.

And what that means is that, unable to scale the density of a chip as Intel can, Qualcomm and Nvidia and Broadcom and the others will not be able to integrate as many parts as Intel on a single semiconductor die.

And so to those who point out that Intel hasn't yet released its integrated baseband chip, Sofia, mentioned above, Eul contends the company will have the last laugh in a few years' time as Qualcomm and the rest hitting a scaling wall.

Following Qualcomm‘s (QCOM) analyst day meeting in New York today, president and COO Steve Mollenkopf was kind enough to talk with me for a few minutes regarding a variety of topics, including emerging market smartphone trends and the battle for tablet computing.

On the latter score, I asked Mollenkopf how he sees Qualcomm faring relative to Intel (INTC), which has received accolades for its latest “Atom” application processor for tablets, “Bay Trail,” released earlier this year.

Mollenkopf assures me that “given the performance we can deliver with Snapdragon 800 or 805, we are not too concerned about where we sit with respect to other vendors,” referring to the company’s most recent models of its application processor family.

On a deeper level, Mollenkopf rejects the notion, propounded by Intel, that tablet computers will be something more like the traditional personal computer, as the category matures in power and performance, supposedly tipping the advantage to Intel as the PC heavyweight. It is a view that was espoused by former Intel CEO Paul Otellini, and that has been taken up by his successor, Brian Krzanich.

“The tablet is not really so much like a PC,” says Mollenkopf.

“There are a number of things that need to be integrated, and here the PC model basically comes up short, such as video.” He offers as an example the Amazon.com (AMZN) “Kindle Fire HDX” tablet released in recent weeks. It uses a Snapdragon 800. “There are many things we did there that differentiate us, things such as the display, to make it more readable in direct sunlight, for example — those are things you wouldn’t do if it weren’t a mobile product.”

“We also incorporated special security features [in the chipset] for the download and storage of rental content on the Kindle Fire.”

In sum, then, the “we look at the tablet as more of a mobile device, more like a phone, and not a laptop.”

When I suggest that Intel has long dominated the use of performance benchmarks to push the prowess of its chips, Mollenkopf bats that aside, replying “As far as benchmarks for tablets, we have created more realistic benchmarks than the stuff that typically gets thrown around in the PC world, benchmarks that are more attuned to the demands of mobile.”

I also asked Mollenkopf about how he sees the next big leap in chip manufacturing playing out, and whether it may prove problematic given that Qualcomm last year suffered through delays in getting parts at the latest technology node, using features measuring 28 billionths of a meter.

Would there be the same problem with this latest technology process, 20-nanometer, I asked?

“20 nano will not be a drama,” he says. “What happened there was, we had so much traction that we couldn’t match the ramp on the front end.”

“But generally speaking, the problem you just had is never the one you will have next,” he says with a wry smile, before adding, more seriously, “We are converting the supply chain from being node-laggard to node-leader, so things will be different this time.”

I ask Qualcomm about Intel’s vaunted prowess in semiconductor process technology, and Intel’s contention, held by some analyst on the Street, that Qualcomm’s partners, such as Taiwan Semiconductor Manufacturing (TSM), may run aground as chip features face more daunting effects at small feature sizes in coming years.

On the one hand, “we have many partners for making chips,” he points out, “and we think there are many companies that will do just fine making transistors at these new technology nodes, including Samsung [Electronics (005930KS), and TSM, and we think GlobalFoundries has a shot as well. We also fab with [China-based] Semiconductor Manufacturing International. So, we think there are a lot of parties who are capable of making transistors.”

At the same time, “We think, unlike our friends up north [Intel], that the transistor is not necessarily the most important thing,” argues Mollenkopf.

“The key component of the transistor moving forward is tuning the transistor for mobile, and having a partner that has the volume for mobile to satisfy demand.”

Intel (INTC) will host its annual analyst day meeting this Thursday, November 21st, in Silicon Valley, and a couple of observers weighed in with thoughts about the first such meeting for CEOBrian Krzanich, who took the helm in May of this year, along with president Renee James following the eight-year tenure of Paul Otellini.

Krzanich will highlight the company’s multi-year semiconductor manufacturing process lead, and the advantages across servers, tablets, networking and other areas, he thinks:

We expect CEO Krzanich to express confidence Moore’s Law will be sustained with transitions to in-progress 14nm, in-development 10nm in 2015, and 7nm in 2017. The cadence – un-impacted by a now-resolved 14nm Broadwell defect intensity issue, would hold a multi-yr lead to industry, as shown by 22nm finFET’s timing.

With products such as the “Xeon E5” family of server chips, the “Haswell” line of PC processors, and the “Bay Trail” processor this year, “INTC can fairly state its portfolio is in the best position in 10+ years,” writes Ellis.

Ellis expects fairly consistent “messaging” as far as financials — mid-teens growth of data center products, a bottoming in the PC market, double-digit growth in embedded chip applications, and a 40% target for the free cash flow paid out as a dividends. Intel may back off of the average $10.8 billion in capital spend the last three years and target something more like $7 billion to $8 billion, which will leave more money for dividends.

In a less sanguine vein, Cowen & Co.’s Timothy Arcuri reiterates a Market Perform rating, arguing demand for “hybrid” PC devices that Intel has championed is uncertain; he also sees lower capex ahead:

The company is well positioned on new PC form factors such as 2-in-1s, but demand for these products remains, to us, very questionable. Competitive ARM solutions have forced Intel to match pricing but the company believes customers are choosing Intel for its technology roadmap as it continues to ramp 22nm, migrate to 14nm and work on integrated LTE solutions. Relative to concerns on growth as ASP mixes lower with Bay Trail, INTC continues to highlight that Bay Trail socket cannibalization should not be looked at relative to a >$100 Core part, but rather relative to a low-end ARM part or what is already a lower ASP Celeron/Pentium part that has not had the right cost structure for that price point. We would expect the company to press this point at the Analyst Mtg this week. On capex, it continues to push more re-use in an effort to combat rapidly rising capital intensity. While headline capex in ’14 could come down to the $9B level from ~$10.8B in ’13, we think this is predominantly related to 450mm (pushed out 18-24mos) and “core” capex will likely fall from ~$9B in ’13 to ~ $8-8.5B in ’14.

Shares of Intel (INTC) are up 20 cents, or 0.9%, at $23.59, after the company last night beatQ3 expectations but forecast this quarter’s results below consensus, while saying it believes the PC market, while still “tough,” may have hit bottom.

Most analysts today did not make much of CEO Brian Krzanich‘s disclosure, on the conference call following the report, that Intel will delay by one quarter its production ramp of new “Broadwell” desktop chips, till Q1, given some issues with getting proper yield from the production process.

The stock received one ratings change today, from Craig Ellis of B. Riley & Co., who raised his rating to Buy from Neutral, and raised his price target to $28.50 from $25, writing that the results confirmed his sense that the PC market is “stabilizing” and that the company’s position in sales of chips for servers and other data center products is encouraging:

With C14 Consensus EPS now down 12% since YE13, Sell Side “Buy” ratings at an 18-yr low, and signs of developed country PC stabilization emerging into C14, we think 9/19 ppt YTD under-performance to the SOX/S&P 500 overly discount PC negatives which may be turning and overlook clear mfg technology and DCG secular positives […] The guide is $13.70B (+1.6%) +/- $500MM with a 150 bps GM decline to 61.0% and flat opex of $4.70B. On a segment basis DGC should surge 15-20% as traditional US/ Europe enterprise finally recovers to compliment ongoing Cloud, HPC and Storage strength. Implicitly this means PC Client will fall 4.0% to 5.0% qq, even greater than the – 3.0% we forecast and far below the Street’s +2.0%. On lower volume and one- offs GM drop 100 bps qq but are flat qq, while tight opex is maintained for a $100M variance to our forecast. So, Street estimates will fall from $14.20B (+4.5%)/ $0.54 while we move from $13.51B (-1.2%)/$0.49 to $13.7B/$0.52.

Intel’s outlook for 8 Bay Trail-based Hybrid-PC/Tablet SKUs shipping for Black Friday are lower than we expected, but we chalk it up to a bumpy product transition. We didn’t hear anything to change our view that Intel’s manufacturing leadership would lead to share gains in low cost/power MPUs. We would use weakness as a buying opportunity.

MKM Partners’s Ada Menaker reiterates a Buy rating, and a $28 price target, writing that “Guidance was better than some investors may have feared,” and that “we continue to like catalysts in coming quarters – these include surging data center demand (helped by a budget flush in “classic” enterprise), a run at QCOM’s (NR, $68.17) exclusivity in wireless LTE modems (product shipping in 2H14), and an increasing competitive advantage as 14nm manufacturing ramps (INTC maintains a technology lead here despite a one-quarter push out).”

Menaker also highlights the momentum in the data center products group, which casts in stark relief the weakness in PCs:

We note an acceleration of Data center growth expected in Q4 (expected above Q3′s 12% Y/Y increase) given a recovery in “classic” enterprise due to an IT budget flush as well as ongoing strength in large data centers. Investors should increasingly focus on fundamentals in DCG, as 22% of Q3 sales continues to increase on outpeformance. Management commentary implies continued weakness in PCs. Commentary around DCG growth expectations (approaching double digit Y/Y growth) implies continued declines in the PC group – we now model a 4.8% decline in 2013, followed by an additional 1.8% in 2014. While management remains excited at the range of new products in the marketplace, we believe there continues to be PC device fatigue due to competing products (tablets, game consoles) and little enthusiasm for touch-enabled ultrabooks (despite the cost added for touch declining to $50). We also note that a one-quarter pushout of Broadwell implies that little product may be available for next year’s back- to-school shopping season – our PC Client estimates thus move lower.

The bears today are still rather skeptical that new “Haswell” processors and “Baytrail” chips will pick up the company’s standing in mobile devices.

Intel believes PC demand in mature markets (U.S. and Western Europe) have bottomed and momentum in new 2-in-1 PCs using its Haswell chip priced sub-$349 and new BayTrail chips priced sub- $299 will be a key driver for the stock in 2014 where we still lack conviction.

Canaccord Genuity‘s Bobby Burleson reiterates a Hold rating, and a $20 price target, writing “the consumer PC market has not reached a bottom and is likely to see escalating cannibalization with the ramp of iPad 5 and competition from low cost tablets in emerging markets.”

“We see the US government shutdown as an additional risk to Q4 guidance, and note that it has recently been added to Intel’s statement of risks.”

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.